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07 Aug 2020

Lamesa v Cynergy: mandatory law in standard form contracts

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The Court of Appeal has upheld a decision that Cynergy Bank was justified in refusing to pay interest to Lamesa Investments in order to comply with “mandatory law” (the potential application of US secondary sanctions). Although the Court of Appeal came to the same conclusion as the High Court, it applied different reasoning. The judgment is particularly of interest because of its analysis of the construction of standard form clauses in finance contracts. 

Background

The background to the case is summarised in our article on the High Court decision available here. In brief, Lamesa is a Cypriot company, ultimately owned by Russian businessman, Viktor Vekselberg. Cynergy Bank is a UK retail bank with a US Dollar correspondent account with a US bank. Lamesa lent £30 million to Cynergy and under the Finance Agreement, Cynergy was required to make interest payments.

In 2018, Mr Vekselberg was placed on a list of “Specially Designated Nationals” by the US Government and Lamesa became a “blocked person”. In addition to the primary sanction applied, US legislation provides that “secondary sanctions” can also be imposed on non-US persons in wholly non-US transactions. It was common ground that the US Government could impose a secondary sanction on Cynergy if it determined that payment of interest to Lamesa constituted a “significant financial transaction”.

Cynergy claimed that because of the potential secondary sanctions, it was unable to pay the circa £3 million due to Lamesa in interest payments, although it had “ring-fenced” this amount. Lamesa brought a Part 8 claim for a declaration on Cynergy’s obligations pursuant to the Finance Agreement.

The High Court’s decision

The key contractual clause provided that: “[Cynergy] shall not be in default if…such sums were not paid in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction.”

At first instance, Cynergy argued that because there was a risk of secondary sanctions being applied to it, this constituted a “mandatory provision of law” from a “court of competent jurisdiction”, justifying its non-payment.

Lamesa’s position was that the risk of secondary sanction was not an express prohibition and that the word “mandatory” should be construed as to mean compulsory.

The High Court held that “mandatory provision of law” meant a law which the parties could not vary or dis-apply. In reaching this decision, the judge observed that it was “improbable” that the parties had meant anything else by the clause because of the evidence that: 1) the parties were aware of the possibility of secondary sanctions being imposed; and 2) Cynergy (as a non-US person) could only ever have been exposed to secondary as opposed to primary sanctions.

The Court of Appeal’s decision

The court agreed that the wording of the clause was ambiguous. Because of that ambiguity, it was permissible to consider relevant context and commercial common sense.

Where the Court of Appeal departed from the analysis at first instance, however, was the operation of the rules of construction in the context of standard form documents. Both parties drew the court’s attention to the Court of Appeal’s ruling in State of Netherlands v Deutsche Bank AG [2019] EWCA Civ 771, which held in relation to ISDA documentation that: “a standard form is not context-specific and evidence of the particular factual background or matrix has a much more limited, if any, part to play”.

Bearing this (and other authorities) in mind, the court concluded that the judge at first instance had overly focussed on the probabilities of what the parties may or may not have intended by the relevant clause, which, it was agreed, was a standard term in loan agreements providing Tier 2 Capital to international banks at the time.

Instead, the court focussed on three areas of admissible context:

  1. the similarity between the contractual clause and the EU Blocking Regulation (which, although having no application in this scenario, it concluded would have been known to the parties and the drafters of the clause);
  2. the fact that the clause was a standard form clause in use by international banks in the provision of Tier 2 Capital; and
  3. the fact that parties providing Tier 2 Capital within the EU at the relevant time would have been aware of the potential problem of US secondary sanctions.

Relevant commercial context

The Court of Appeal considered that the similarity between the wording of the clause and that of the EU Blocking Regulation (which operates to prohibit EU companies and individuals from complying with certain US secondary sanctions currently in place against Cuba and Iran which impose a "requirement or prohibition" on entities or persons outside of the US) was significant. The fact that the drafters of the clause knew that the EU Blocking Regulation regarded US secondary sanctions as legislation with which they were otherwise required to “comply” was, it considered, a “compelling argument in favour of Cynergy’s interpretation”.  The Court of Appeal disagreed with Cynergy and the judge at first instance's interpretation of the word "mandatory".  The court held that a provision is mandatory in this context if it imposes a "requirement or prohibition", the terms used in the EU Blocking Regulation to describe a provision which requires a person to do or to refrain from doing a specified act.

It was also relevant, the court considered, that the facility itself was not a “parochial loan agreement”. As noted at first instance, the parties would have been aware of the potential of US secondary sanctions. If the clause were construed as excusing non-payment only in the event a statute directly required Cynergy not to make payment, the utility of the clause would be “badly dented”, such that it would have “almost no possibility of taking effect”.

The court considered what was meant by the words “in order to comply with”. Lamesa argued that Cynergy was not complying with the legislation itself but the policy behind it. On balance, the Court of Appeal concluded that although US secondary sanctions cannot prohibit payment by Cynergy to Lamesa, its effect is one of prohibition. In that context, Cynergy’s non-payment should be construed as an action taken in order to comply with that legislation.

Commentary

The Court of Appeal acknowledged that this was not an easy case, with Lord Justice Arnold concluding: “Although I have doubts about this, in the end I do not dissent”. While the Court of Appeal adopted different reasoning to the High Court, it came to the same conclusion: foreign secondary sanctions can, in certain circumstances, be construed as “mandatory laws” with which parties must comply. This ruling highlights the importance for parties to finance agreements to ensure they fully understand the risks of laws with extraterritorial effect, including secondary sanctions. Where the contract does not specifically provide for the imposition of secondary sanctions, parties (in particular non-US parties) need to be aware of the likely interpretation of any standard clauses to ensure that they reflect the parties’ agreed positions.

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